First Department Holds Source Code to Be a Trade Secret and Defines Bounds of Judicial Proceedings Privilege

On November 12, 2019, in BEC Capital, LLC et al. v. Bistrovic et al., 177 A.D.3d 438 (1st Dep’t 2019), the Appellate Division, the First Department issued a decision reversing an order of the Commercial Division and holding that the Defendants’ source code is a trade secret, and therefore should have been ordered to be produced under an “attorneys and expert eyes only” form of review.[1]  The First Department also held that an email produced prior to the litigation was not subject to privilege from defamation and thus could support Defendants’ counter-claim for defamation.[2]

In the Commercial Division, Justice Ramos had directed Defendants to produce its source code to Plaintiffs, or otherwise be precluded from asserting related counterclaims and defenses in the action.[3]  Justice Ramos rejected Defendants’ motion for a protective order that would have limited disclosure of the source code for review by designated outside counsel and Plaintiffs’ expert eyes only.[4]  Instead, Justice Ramos directed the parties to follow the disclosure rules in Commercial Division Rule 11-g.[5]  Justice Borrok, who later assumed Justice Ramos’s position on the Commercial Division, issued an order directing Defendants to produce the source code information to Plaintiffs, consistent with Justice Ramos’s prior order.[6]  Justice Borrok also so-ordered a September 2018 hearing transcript in which Justice Ramos denied Defendants’ motion for leave to amend their counter-claims.[7]  This started the clock for Defendants to appeal Justice Ramos’s decisions.

Defendants appealed to the First Department and sought an emergency motion to stay the Commercial Division’s rulings.  The First Department granted Defendants’ motion for an emergency stay of those orders pending the outcome of the appeal.[8] 

On appeal, Defendants argued that its source code constitutes confidential and proprietary trade secrets, and accordingly Defendants were entitled to restrict production of the material to a confidentiality stipulation and order that would prevent Plaintiffs themselves from viewing the material.[9]  Defendants argued that after the breakdown of the parties’ relationship, the parties had become competitors, Defendants had expended substantial resources in developing the source code, and Defendants feared that the source code could be misappropriated by Plaintiffs should it be disclosed to them directly.[10]  For these reasons, Defendants maintained that the outside counsel and expert only designation was necessary before making the requested disclosure.

The First Department agreed, citing an Eastern District of New York decision, Dynamic Microprocessor Assocs. v. EKD Computer Sales.[11]  Although not discussed by the First Department, the Eastern District decision went far beyond the “outside counsel only” designation sought by Defendants.  In Dynamic Microprocessor, the Eastern District strictly conditioned the production of the source code, placing the following protections on production:  (1) the production was confidential; (2) subject to attorney’s eyes only; (3) no copies or duplicates could be made and at the end of the litigation and the source code had to be returned; (4) any notes from the experts related to the source code had to be returned at the end of the litigation; (5) the expert reports describing and discussing the source code would be produced and subject to all the same conditions as the produced source code; and (6) the experts had to keep an authorized log of any personnel who examined the code.[12] 

In light of how other courts have treated source codes as protected trade secrets, Defendants’ request to restrict production of the source code information to Plaintiffs’ counsel and expert only was reasonable considering the sensitive and competitive nature of that information.  As cases continue to be litigated before the Commercial Division it would be helpful for the First Department to continue weighing in on when it is appropriate for parties to seek permission to deviate from the Commercial Division’s standard forms and practices, especially where the rules permit the parties to request additional tailoring to meet their circumstances, as in Rule 11-g.

In BEC Capital, the First Department also decided another interesting issue on privilege from defamation.[13]  Defendants’ proposed defamation counter-claim was based on an email that Plaintiff sent to two non-parties prior to the litigation.[14]  Justice Ramos excluded that email as privileged and in turn dismissed Defendants’ proposed defamation claim, concluding that the email covered the same subject matter as the judicial proceeding and there was no damage to Defendants as a result of the email.[15] 

In reversing this ruling, the First Department determined that the email was not protected by the common law privilege that applies to statements in the context of a judicial proceeding or the statutory privilege provided in Civil Rights Law § 74.[16]  This was likely due to the fact that the email was sent outside the litigation and was between non-parties to the lawsuit.[17]  The First Department then granted leave to Defendants to amend their answer to assert a claim for defamation.[18]   This decision serves as a reminder of the contours of the common law privilege from defamation as applied to judicial proceedings.